Antitrust

Origins

Before 1890, the only “antitrust” law was the common law. Contracts that allegedly restrained trade (e.g., price-fixing agreements) often were not legally enforceable, but they did not subject the parties to any legal sanctions, either. Nor were monopolies illegal. Economists generally believe that monopolies and other restraints of trade are bad because they usually reduce total output, and therefore the overall economic well-being for producers and consumers (see monopoly). Indeed, the term “restraint of trade” indicates exactly why economists dislike monopolies and cartels. But the law itself did not penalize monopolies. The Sherman Act of 1890 changed all that by outlawing cartelization (every “contract, combination . . . or conspiracy” that was “in restraint of trade”) and monopolization (including attempts to monopolize).

The Sherman Act defines neither the practices that constitute restraints of trade nor monopolization. The second important antitrust statute, the Clayton Act, passed in 1914, is somewhat more specific. It outlaws, for example, certain types of price discrimination (charging different prices to different buyers), “tying” (making someone who wants to buy good A buy good B as well), and mergers—but only when the effects of these practices “may be substantially to lessen competition or to tend to create a monopoly.” The Clayton Act also authorizes private antitrust suits and triple damages, and exempts labor organizations from the antitrust laws.

Economists did not lobby for, or even support, the antitrust statutes. Rather, the passage of such laws is generally ascribed to the influence of populist “muckrakers” such as Ida Tarbell, who frequently decried the supposed ability of emerging corporate giants (“the trusts”) to increase prices and exploit customers by reducing production. One reason most economists were indifferent to the law was their belief that any higher prices achieved by the supposed anticompetitive acts were more than outweighed by the pricereducing effects of greater operating efficiency and lower costs. Interestingly, Tarbell herself conceded, as did “trustbuster” Teddy Roosevelt, that the trusts might be more efficient producers.

Only recently have economists looked at the empirical evidence (what has happened in the real world) to see whether the antitrust laws were needed. The popular view that cartels and monopolies were rampant at the turn of the century now seems incorrect to most economists. Thomas DiLorenzo (1985) has shown that the trusts against which the Sherman Act supposedly was directed were, in fact, expanding output many times faster than overall production was increasing nationwide; likewise, the trusts’ prices were falling faster than those of all enterprises nationally. In other words, the trusts were doing exactly the opposite of what economic theory says a monopoly or cartel must do to reap monopoly profits.

Anticompetitive Practices

In referring to contracts “in restraint of trade,” or to arrangements whose effects “may be substantially to lessen competition or to tend to create a monopoly,” the principal antitrust statutes are relatively vague. There is little statutory guidance for distinguishing benign from malign practices. Thus, judges have been left to decide which practices run afoul of the antitrust laws.

An important judicial question has been whether a practice should be treated as “per se illegal” (i.e., devoid of redeeming justification, and thus automatically outlawed) or whether it should be judged by a “rule of reason” (its legality depends on how it is used and on its effects in particular situations).

To answer such questions, judges sometimes have turned to economists for guidance. In the early years of antitrust, though, economists were of little help. They had not extensively analyzed arrangements such as tying, information sharing, resale price maintenance, and other commercial practices challenged in antitrust suits. But as the cases exposed areas of economic ignorance or confusion about different commercial arrangements, economists turned to solving the various puzzles.

Indeed, analyzing the efficiency rationale for practices attacked in antitrust litigation has dominated the intellectual agenda of economists who study what is called industrial organization. Initially, economists concluded that unfamiliar commercial arrangements that were not explicable in a model of perfect competition must be anticompetitive. In the past forty years, however, economic evaluations of various practices have changed. Economists now see that the perfect competition model relies on assumptions—such as everyone having perfect information and zero transaction costs—that are inappropriate for analyzing real-world production and distribution problems.

The use of more sophisticated assumptions in their models has led economists to conclude that many practices previously deemed suspect are not typically anticompetitive. This change in evaluations has been reflected in the courts. Per se liability has increasingly been superseded by rule-of-reason analysis reflecting the procompetitive potential of a given practice. Under the rule of reason, courts have become increasingly sophisticated in analyzing information and transaction costs and the ways that contested commercial practices can reduce them. Economists and judges alike are more sophisticated in several important areas.

Vertical Contracts

Most antitrust practitioners once believed that vertical mergers (i.e., one company acquiring another that is either a supplier or a customer) reduced competition. Today, most antitrust experts believe that vertical integration usually is not anticompetitive.

Progress in this area began in the 1950s with work by Aaron Director and the Antitrust Project at the University of Chicago. Robert Bork, a scholar involved with this project (and later the federal judge whose unsuccessful nomination to the U.S. Supreme Court caused much controversy), showed that if firm A has monopoly power, vertically integrating with firm B (or acquiring B) does not increase A’s monopoly power in its own industry. Nor does it give A monopoly power in B’s industry if that industry was competitive in the first place.

Lester Telser, also of the University of Chicago, showed in a famous 1960 article that manufacturers used resale price maintenance (“fair trade”) not to create monopoly at the retail level, but to stimulate nonprice competition among retailers. Since retailers operating under fair trade agreements could not compete by cutting price, noted Telser, they instead competed by demonstrating the product to uninformed buyers. If the product is a sophisticated one that requires explaining to prospective buyers, resale price maintenance can be a rational—and competitive—action by a manufacturer. The same rationale can account for manufacturers’ use of exclusive sales territories. This new knowledge about vertical contracts has had a large impact on judicial antitrust rulings.

Horizontal Contracts

Changes in the assessment of horizontal contracts (agreements among competing sellers in the same industry) have come more slowly. Economists remain almost unanimous in condemning all horizontal price-fixing. Many, however (e.g., Donald Dewey), have indicated that price-fixing may actually be procompetitive in some situations, a conclusion bolstered by Michael Sproul’s empirical finding that in industries where the government successfully sues against price-fixing, prices increase, rather than decrease, after the suit. At a minimum, Peter Asch and Joseph Seneca have shown empirically, price-fixers have not earned higher than normal profits. Other practices that some people believed made it easier for competitors to fix prices have been shown to have procompetitive explanations. Sharing of information among competitors, for example, may not necessarily be a prelude to price-fixing; it can instead have an independent efficiency rationale.

Perhaps the most important change in economists’ understanding has occurred in the area of mergers. Particularly with the work of Joe Bain and George Stigler in the 1950s, economists (and courts) inferred a lack of competition in markets simply from the fact that an industry had a high four-firm concentration ratio (the percentage of sales accounted for by the four largest firms in the industry). But later work by economists such as Yale Brozen and Harold Demsetz demonstrated that correlations between concentration and profits either were transitory or were due more to superior efficiency than to anticompetitive conduct. Their work followed that of Oliver Williamson, who showed that even if merger caused a large increase in monopoly power, it would be efficient if it produced only slight cost reductions. As a result of this new evidence and new thinking, economists and judges no longer assume that concentration alone indicates monopoly. The various versions of the Department of Justice/Federal Trade Commission Merger Guidelines promulgated in the 1980s and revised in the 1990s have deemphasized concentration as a factor inviting government challenge of a merger.

Nonmerger Monopolization

Perhaps the most publicized monopolization case of recent years is the government’s case against Microsoft, which (see Liebowitz and Margolis 2001) rested on questionable empirical claims and resulted ultimately in victory for Microsoft on most of the government’s allegations. The failure of the government’s case reflects a general recent decline in the importance of monopolization cases. Worries about monopoly have progressively diminished with the realization that various practices traditionally thought to be monopolizing devices (including vertical contracts, as discussed above) actually have procompetitive explanations. Likewise, belief in the efficacy of predatory pricing—cutting price below cost—as a monopolization device has diminished. Work begun by John McGee in the late 1950s (also an outgrowth of the Chicago Antitrust Project) showed that firms are highly unlikely to use predatory pricing to create monopoly. That work is reflected in several recent Supreme Court opinions, such as that in Matsushita Electric Industrial Co. v. Zenith Radio Corp., where the Court wrote, “There is a consensus among commentators that predatory pricing schemes are rarely tried, and even more rarely successful.”

As older theories of monopolization have died, newer ones have been hatched. In the 1980s, economists began to lay out new monopolization models based on strategic behavior, often relying on game-theory constructs. They postulated that companies could monopolize markets by raising rivals’ costs (sometimes called “cost predation”). For example, if firm A competes with firm B and supplies inputs to both itself and to B, A could raise B’s costs by charging B a higher price. It remains to be seen whether economists will ultimately accept the proposition that raising a rival’s costs can be a viable monopolizing strategy, or how the practice will be treated in the courts. But courts have sometimes imposed antitrust liability on firms possessing supposedly “essential facilities” when they deny competitors access to those facilities.

The recent era of antitrust reassessment has resulted in general agreement among economists that the most successful instances of cartelization and monopoly pricing have involved companies that enjoy the protection of government regulation of prices and government control of entry by new competitors. Occupational licensing and trucking regulation, for example, have allowed competitors to alter terms of competition and legally prevent entry into the market. Unfortunately, monopolies created by the federal government are almost always exempt from antitrust laws, and those created by state governments frequently are exempt as well. Municipal monopolies (e.g., taxicabs, utilities) may be subject to antitrust action but often are protected by statute.

The Effects of Antitrust

With the hindsight of better economic understanding, economists now realize that one undeniable effect of antitrust has been to penalize numerous economically benign practices. Horizontal and especially vertical agreements that are clearly useful, particularly in reducing transaction costs, have been (or for many years were) effectively banned. A leading example is the continued per se illegality of resale price maintenance. Antitrust also increases transaction costs because firms must hire lawyers and often must litigate to avoid antitrust liability.

One of the most worrisome statistics in antitrust is that for every case brought by government, private plaintiffs bring ten. The majority of cases are filed to hinder, not help, competition. According to Steven Salop, formerly an antitrust official in the Carter administration, and Lawrence J. White, an economist at New York University, most private antitrust actions are filed by members of one of two groups. The most numerous private actions are brought by parties who are in a vertical arrangement with the defendant (e.g., dealers or franchisees) and who therefore are unlikely to have suffered from any truly anticompetitive offense. Usually, such cases are attempts to convert simple contract disputes (compensable by ordinary damages) into triple-damage payoffs under the Clayton Act.

The second most frequent private case is that brought by competitors. Because competitors are hurt only when a rival is acting procompetitively by increasing its sales and decreasing its price, the desire to hobble the defendant’s efficient practices must motivate at least some antitrust suits by competitors. Thus, case statistics suggest that the anticompetitive costs from “abuse of antitrust,” as New York University economists William Baumol and Janusz Ordover (1985) referred to it, may actually exceed any procompetitive benefits of antitrust laws.

The case for antitrust gets no stronger when economists examine the kinds of antitrust cases brought by government. As George Stigler (1982, p. 7), often a strong defender of antitrust, summarized, “Economists have their glories, but I do not believe that antitrust law is one of them.” In a series of studies done in the early 1970s, economists assumed that important losses to consumers from limits on competition existed, and constructed models to identify the markets where these losses would be greatest. Then they compared the markets where government was enforcing antitrust laws with the markets where governments should enforce the laws if consumer well-being was the government’s paramount concern. The studies concluded unanimously that the size of consumer losses from monopoly played little or no role in government enforcement of the law. Economists have also examined particular kinds of antitrust cases brought by the government to see whether anticompetitive acts in these cases were likely. The empirical answer usually is no. This is true even in price-fixing cases, where the evidence indicates that the companies targeted by the government either were not fixing prices or were doing so unsuccessfully. Similar conclusions arise from studies of merger cases and of various antitrust remedies obtained by government; in both instances, results are inconsistent with antitrust’s supposed goal of consumer well-being.

If public-interest rationales do not explain antitrust, what does? A final set of studies has shown empirically that patterns of antitrust enforcement are motivated at least in part by political pressures unrelated to aggregate economic welfare. For example, antitrust is useful to politicians in stopping mergers that would result in plant closings or job transfers in their home districts. As Paul Rubin documented, economists do not see antitrust cases as driven by a search for economic improvement. Rubin reviewed all articles written by economists that were cited in a leading industrial organization textbook (Scherer and Ross 1990) generally favorable to antitrust law. Per economists’ evaluations, more bad than good cases were brought. “In other words,” wrote Rubin, “it is highly unlikely that the net effect of actual antitrust policy is to deter inefficient behavior.. . . Factors other than a search for efficiency must be driving antitrust policy” (Rubin 1995, p. 61). What might those factors be? Pursuing a point suggested by Nobel laureate Ronald Coase (1972, 1988), William Shughart argued that economists’ support for antitrust derives considerably from their ability to profit personally, in the form of full-time jobs and lucrative part-time work as experts in antitrust matters: “Far from contributing to improved antitrust enforcement, economists have for reasons of self-interest actively aided and abetted the public law enforcement bureaus and private plaintiffs in using the Sherman, Clayton and FTC Acts to subvert competitive market forces” (Shughart 1998, p. 151).

About the Author

Fred S. McChesney is the Class of 1967 James B. Haddad Professor of Law at Northwestern University School of Law and a professor in the Kellogg School of Management at Northwestern.

Rubin, Paul H. “What Do Economists Think About Antitrust? A Random Walk down Pennsylvania Avenue.” In Fred S. McChesney and William F. Shughart II, eds., The Causes and Consequences of Antitrust: The Public-Choice Perspective. Chicago: University of Chicago Press, 1995.

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